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Fed Signals Average Inflation Targeting At The Jackson Hole Symposium

Posted: Monday, August 31st, 2020

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Average Inflation Targeting (AIT) is on everybody’s lips these days. The Federal Reserve of the United States (Fed) changed its price stability mandate to AIT and made the announcement at the Jackson Hole Symposium last week.

The news was highly anticipated, and the USD sold into the event. Yet, some market participants wanted the Fed to offer more clues about AIT and how it views the process of averaging inflation.

Average Inflation Targeting

But the Fed did not offer many details at this point. What we know is that it is unwilling to react if inflation overshoots the 2% target unless the average inflation aims to reach the target.

More precisely, the Fed will not react if inflation overshoots above the 2% target. Is this something new? Not really, as the Fed signaled in the past  a symmetrical 2% inflation target. However, the shift to average inflation targeting shows a more dedicated Fed and may provide a framework for other central banks to follow.

Average Inflation Targeting  and the Era of Cheap Money

When Christine Lagarde took the helm of the ECB in late 2019, she started a monetary policy review program. Forecasted to last around twelve months, the program reconsiders the ECB’s mandate – price stability.

With last week’s move, the Fed stole the show. It becomes, once again, the most proactive central bank in the developed world, and the move to AIT may be quickly copied by peer central banks in the world.

Unlike the ECB, the Fed has a dual mandate. Besides price stability, it looks at job creation too. With the current change, the price stability mandate becomes more important in the Fed’s eyes.

Truth be told, central banks in the developed world had a hard time sending inflation to the 2% target. From Japan to Australia, Europe to Canada, inflation failed to reach the target. Consensus among economists exists that the 2% inflation is high enough so to avoid deflation and low enough so as not to jeopardize the value of money and economic growth.

By being willing to let inflation run higher, the Fed actually says that it will keep the federal funds rate lower for longer. Because it had a hard time pushing inflation to the target in the past, it will have an equally hard time doing so in the future.

In other words, instead of expecting inflation above 2% in the near future, investors should focus more on the actual message sent by the Fed. That is, no rate hikes anytime soon, regardless if unemployment drops and inflation rises.

Welcome to the era of cheap money.

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